Congressional Intransigence Jeopardizes U.S.

Only in Washington could an agreement designed to avert a fiscal crisis actually add to, rather than decrease, the government's annual budget deficits and, ultimately, the national debt. But that's exactly what the deal Congress agreed to on New Year's day has done.

What a gift the American people.

The fiscal cliff agreement added $4 trillion to budget deficits over the next decade, according to the Congressional Budget Office (CBO). As always, Congress put off many tough decisions and even punted on some rather easy ones.

For example, as part of the fiscal cliff agreement, lawmakers extended dozens of business and industry tax breaks to the tune of at least $67.9 billion this year, according to Congress' Joint Committee on Taxation.

The breaks for these special interests are exactly the kinds of things that Congress should have been targeting, not extending. For example, Congress extended tax breaks for the moguls who own car racing tracks, saving them about $70 million over the next two years.

This should have been the easy stuff. What happens when Congress actually has to make the really tough choices, the ones it has been putting off for many years? That moment will soon be at hand.

A great way for Congress to begin addressing its deficits and debt would be to end all corporate welfare to Big Agriculture, Big Pharma, Big Oil and Big Insurance — to name but a few privileged, and very profitable, industries that continue to feed off the American tax-payer.

But those are the wealthy, powerful special interests that pay for political campaigns, and ours is clearly a pay-to-play system. It's quid pro quo, not money for nothin'.

Instead of addressing corporate welfare, Congress did, however, raise the tax rate of the wealthiest Americans. Yet, that alone won't be nearly enough to address our deep fiscal imbalances.

As of January 1, the top income tax rate increased from 35 percent to 39.6 percent for individuals with at least $400,000 of taxable income, or couples with at least $450,000.

The problem for the federal government is that raising taxes on such a limited number of people won't rectify the revenue shortfall.

The original proposal would have raised income taxes on those with household income above $250,000, and individuals earning more than $200,000. But raising the tax threshold to $400,000 shrank the number of Americans affected, thereby sacrificing lots of additional revenue.

While nearly 2 percent of filers have adjusted gross incomes over $250,000, only 0.6 percent have incomes above $500,000, according to the Tax Policy Center. So a very small number of taxpayers have been affected, and the revenue raised will be insufficient to truly address the government's revenue shortfalls.

Moreover, what's the point of this new marginal tax rate if the effective tax rate is something lower?

Wealthy Americans can afford top-notch tax lawyers and crafty accountants who use an array of loopholes, deductions and exemptions to avoid paying the top marginal rate. Additionally, the wealthiest Americans also utilize offshore tax shelters to avoid taxes.

Sen. Bernie Sanders addressed the problem this way:

"We have got to eliminate loopholes in the tax code that allow large corporations and the wealthy to avoid more than $100 billion in taxes every year by setting up offshore tax shelters in places like the Cayman Islands, Bermuda and the Bahamas. This situation has become so absurd that one five-story office building in the Cayman Islands is now the "home" to more than 18,000 corporations."

The obvious solution is to lower marginal rates while closing all loopholes, write-offs and deductions, which would make tax preparation simple and straight forward. It would also make the tax code fairer and more effective. For example, perhaps the top rate could drop to something more like 33 percent.

Sooner than later, the government must get serious about fiscal policy, both on the revenue side of the equation and on the spending side. One or the other won't do.

As I've said repeatedly on this page, the government has a major spending problem. In the last fiscal year, the government spent 22.4 percent of gross domestic product (GDP). Though the government certainly has a role to play, right now it is just too big.

A 1998 Congressional Joint Economic Committee study concluded that the optimal size of government to maximize economic growth is about 18 percent of GDP.

However, the government also has a revenue problem. Federal revenue is now at 15.8 percent of GDP, lower than it was 60 years ago. Tax revenues have a historical average of 18 percent of GDP.

So, If spending were reduced to the recommended 18 percent level and revenues increased to their historical average, it would obviously result in balanced budgets.

However, that still wouldn't begin to address the $16.4 trillion debt; only continued surpluses would do that. But the best way to get out of a hole is to first stop digging.

The three biggest drivers of the debt have been:

1. More than $3 trillion in tax cuts that were not paid for with spending reductions.

2. Two wars that were not paid for.

3. An economic crash that led to the lowest revenues and the highest expenditures — as a percentage of GDP — in 60 years.

The U.S. narrowly averted a depression and, as a result, its debt exploded.

If that wasn't tough enough, now comes the really hard part: budget cutting.

In poll after poll, the most popular budget item for cutting is foreign aid. But that is a very small portion of the overall budget. In fiscal 2010, the United States spent $52.7 billion on foreign aid out of a federal budget of $3.55 trillion. In other words, foreign aid amounted to just 1.5 percent of the budget.

To really address the problem, Congress can't just tinker at the margins with small budget items, such as foreign aid.

However, the concern of almost every economist is the effect that budget cuts will have on the economy, which has grown so reliant on government input.

With government spending now fueling more than 22% of the U.S. economy, deep budget cuts could quickly derail the limited growth coming from the private sector (households and businesses). The Conference Board estimates that the U.S. economy grew just 2.1 percent in 2012, and that was before any of the pending cuts.

Fortunately, federal deficits are on the decline, though most Americans are probably unaware of this. Federal deficits have been steadily dropping as a percent of the total economy, or GDP, for four consecutive years.

For the fiscal year ending in September 2009, the deficit was 10.1 percent of GDP. In 2010, it was 9 percent. In 2011, 8.7 percent. In the 2012 fiscal year, it was down to 7 percent.

Yet, here's the rub: economists agree that a nation's deficit should not exceed 3 percent of GDP in any given year. The U.S. deficit is still more than twice that level.

Low interest rates are the only thing saving the U.S. from outright crisis as present. In fiscal 2012, the federal government spent $359.8 billion in interest payments on the national debt — and that was the lowest in four years.

The federal government collected $2.469 trillion in revenue in fiscal 2012. So the $359.8 billion spent on interest payments accounted for 15 percent of total revenues. That's money not spent on infrastructure, or healthcare or R&D.

Since 2008, the average interest payment has been more than $412 billion annually. But that could change in a hurry.

Historically, from 1971 until 2012, the United States interest rate averaged 6.2 percent. But the benchmark interest rate in the U.S. hasn't been above 0.25 percent since December 2008.

Most analysts expect short-term rates to begin rising soon. A mere 1 percent increase in interest rates could have a huge impact on government debt payments. Consider that 1 percent of the $16.4 trillion national debt is $164 billion. That's significant.

Under the CBO’s rosiest estimates, total Federal Debt is projected to rise to at least $21.7 trillion by 2022. However, the debt could also be as high as $29.2 trillion by that time.

If interest rates were to rise faster than inflation, it could pose a real threat to the U.S. economy.

With the economy growing so slowly, it is not possible to grow our way out of debt. The government's only hope is to inflate its way out of debt. That's because inflation reduces the value of the dollar. Since our debts are based on a specific dollar amount and not a specific value, the less our dollars are worth, the easier it will be for the government to pay off its debts.

Many of the nation's problems are so deeply entrenched that they will not be easily fixed — if they can be fixed at all. But inasmuch as some of our fiscal problems may have political solutions, our government is gripped by partisanship and intransigence.

The fiscal cliff agreement has delayed $110 billion in automatic spending cuts for two months, meaning those cuts will now occur simultaneously with the debt ceiling in late February. That will lead to the next major political melodrama and economic crisis in Washington.

As if that weren't enough reason for concern, the government has been operating since October 1st without a formal 2013 budget. In lieu of one, the president signed a stop-gap measure in the interim (called a "continuing resolution") which is currently funding the government. Aside from the fact that this is no way to run a government, the continuing resolution expires on March 27th. Yet, the fiscal year doesn't end until September 30th.

House Republicans have such deep ideological convictions that they say they are willing to let the nation default on its debt, which is unprecedented in U.S. history. At a minimum, they are inclined to shut down the government on March 27th in order to get the deep spending cuts they desire. Compromise doesn't appear to be on their agenda.

That will likely result in an epic political battle that will make the fiscal cliff fight look tame in comparison.

Perhaps all three of the above matters (the spending cuts, lifting the debt ceiling, and approval of the fiscal 2013 budget) will be negotiated all at once. Congress clearly has a lot to do and it must act quickly. But it would hardly surprise anyone if Congress is undone by its own obstinacy and fails to act.

Raising the debt ceiling is a matter paying bills the government has already incurred, not for funding additional spending going forward. If lawmakers are not wiling to pay for the budgets they approved (especially deficit spending), they shouldn't have voted for those budgets in the first place.

Fitch Ratings said the debt ceiling is an "ineffective and potentially dangerous mechanism" for enforcing fiscal discipline because it doesn't prevent the tax and spending decisions that will push the debt above the ceiling, while the penalty for not raising the limit is the risk of a sovereign default.

In August 2011, a delay in raising the debt ceiling caused one of the major ratings agencies (Standard & Poor's) to strip the U.S. of its vaunted triple-A status. It marked the first time that the U.S. had ever been below triple-A.

The three major bond rating agencies have warned that a failure to reach a credible deal to contain federal budgets deficits could bring yet another downgrade.

However, Congress can't even agree on relatively small budget cuts.

The reductions associated with the fiscal cliff (which had so many people in a panic) amount to about $1.2 trillion over 10 years, or just $110 billion a year.

Here's a little perspective:

The enacted budget for fiscal 2012, which ended on September 30th, had a deficit of $1.327 trillion.

In other words, these planned budget cuts — which will occur over the course of a decade — amount to less than one year's budget deficit.

That should give you a sense of the magnitude of this problem.